Is It Time To Buy Banks Again?

Bank shares were one of the best investments you could have made this year.

Don't let the moaners and groaners fool you. Despite all the negative press, banks have recently been a fantastic investment. These shares have all trounced the FTSE 100 (UKX) index. Bank shares continue to hit new highs.

1) Barclays

Barclays is the outstanding share in the group. It has suffered the most negative press in the year due to its role in the LIBOR scandal. Perhaps as a result, its shares now demonstrate great value.

The low price-to-earnings (P/E) ratio suggests that the investment community are worried about the bank's likely future earnings.

Prior to the LIBOR scandal, Barclays' Bob Diamond was one of the highest paid men in British banking. Much is made in the industry of the importance of high pay to retain key staff. Yet since the controversial Mr Diamond left his role as chief executive, the shares are up almost 50%.

Ironically, I think a LIBOR fine would be good for Barclays' share price. This would help analysts quantify the precise cost of the scandal and get back to examining Barclays' underlying business.

2) HSBC

HSBC is often preferred as the most geographically diverse of the UK's banks. In 2011, the bank made 21.3% of total profits in Europe and 26.6% in Hong Kong. 34.2% was made in the rest of the Asia-Pacific region and 10.6% was made in Latin America.

This diverse income base helped HSBC weather the financial crisis better than many of its peers. The bank continued to pay a dividend throughout the downturn. Although that dividend was cut in 2008 and again in 2009 it has since been increasing. The dividend forecasts suggest that HSBC management is determined to increase the payout ahead of inflation. A 5.5% advanced is expected for the current year, followed by a 9.5% increase for 2013.

Given the bank's demonstrated resilience, the shares look like they could still be cheap. The average FTSE 100 share trades on a P/E of 14.9. Is HSBC's 33% discount deserved?

3) Lloyds Banking

Lloyds is the big winner this year with its shares doubling in the last 12 months. This has left the shares looking rather expensive. However, there is a case that the shares might still be cheap.

Due to the expense incurred meeting Payment Protection Insurance (PPI) claims, profits at Lloyds this year will be depressed. PPI will wipe over two billion pounds off profits this year, hence Lloyds' high 2012 P/E.

The other part of Lloyds' story is the rate of asset impairment. This is Lloyds' measure of losses on its assets and loans. In the bank's most recent trading statement, it reported £1.35bn of such losses. While this may sound a lot, it was 40% less than the cost one year previously.

4) Royal Bank of Scotland

Royal Bank of Scotland is majority-owned by the taxpayer. Of the five, RBS came closest to bankruptcy during the financial crisis.

RBS has the largest 'beta' of the FTSE 100's banks. The 'beta' is a measure of the volatility in a share price versus the volatility of the index. The result is that owning RBS shares can be a roller-coaster ride.

The three main risks specific to RBS are impairments, LIBOR and PPI.

Impairments at RBS have also been falling. In its most recent quarterly statement, RBS reported an 11.9% fall in group impairments. Although that's a smaller decline than Lloyds announced, losses are heading in the right direction. While RBS may well cop a fine for LIBOR rigging, its involvement is likely less than Barclays'.

5) Standard Chartered

Standard Chartered is the bank that UK investors often forget. Over 90% of the bank's profits are generated in Asia, Africa and the Middle East. It is only the bank's sponsorship of Liverpool FC that makes them a household name in the UK.

Standard Chartered survived the financial crisis better than any other UK-listed bank. Although the dividend was cut 11% for 2008, it increased in every other year. The shareholder payout is now higher than it was before the credit crunch began.

Standard Chartered hasn't been without problems. Earlier this year, US regulators fined the bank $340m over transactions Standard Chartered had processed for Iranian clients. This scandal has caused the bank's shares to lose almost 30% of their value.

Standard Chartered is expected to increase earnings 8.7% this year and 8.8% the next.

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> David owns shares in Lloyds Banking and RBS but none of the other companies mentioned. The Motley Fool owns shares in Standard Chartered.

It's looking expensive on a current-year forecast P/E of 18.6. That means it's predicted to generate earnings this year for its shareholders at a rate of 5.4% - only a couple of percentage points above what you could get on a good bank account if you're going to tie up your money for a while. Not a great deal of compensation for the considerably higher risk involved in owning shares and the fact that it is unlikely to pay out much of those earnings to the shareholders as dividends...

It's only a tenth of the share price five years ago, but the earnings are only about a 20th of those five years ago. So while it may look cheap on price compared with then, it doesn't on value for money...

That's all mitigated by the 12.3 P/E forecast for next year. That means its rate of generating earnings is forecast to rise to 8.1%, which is more like 4-5 percentage points above what you could get on a good bank account. But still much less than the 15% that Barclays's P/E of 6.6 implies... I.e. its higher P/E than the other banks means it looks expensive compared with them: you have to pay more for the same amount of forecast earnings.

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